Fiscal Policy

The government can also use its own spending and taxing
activities to achieve specific objectives. This is called fiscal
policy. By increasing or decreasing its spending or taxing
programs, the federal government may reduce or increase demand
for goods and services. If the government reduces its own
spending, it buys less from businesses, reducing sales and
earnings, and people have less money to spend. Similarly, if the
government raises taxes, people have less money to spend.
Moreover, spending and taxing policies work together to increase
or decrease aggregate demand. For example, if the government
taxes to a greater extent than it spends, it causes a net
reduction in the flow of income to people and businesses. Because
this reduces aggregate demand for goods and services, it is a
method for fighting inflation.

Fiscal policy uses budget deficits or surpluses to promote
economic stability and growth. In the United States, some fiscal
policy tools work automatically -- without action being taken by
the president or Congress. The progressive income tax, for
example, is generally considered to promote stability
automatically. It tends to reduce the government's collection of
revenue when personal and business incomes are declining, and
thus helps offset the cutbacks in spending that accompany
declining incomes. During business expansions, however, federal
tax collection tends to rise fairly quickly and thus reduce
inflationary pressures. During postwar business declines,
Congress has sometimes legislated emergency spending measures,
such as temporary increases in public works expenditures, as
additional means of offsetting cutbacks in private spending and
preventing unemployment.

Yet there are also problems associated with the use of fiscal
policy. Many object to a reduction in government spending because
this could mean a reduction in funds used to help provide
education, health care and other services. Higher taxes are
unpopular with both individuals and businesses. In addition, the
use of fiscal policy to cause a sharp reduction in demand is
somewhat controversial because it tends not only to reduce
inflation but also to increase unemployment.